JULY 2004

ABCs of Accounting: Available Tax Credits for Working Parents

Working parents are faced by many challenges as they juggle work and family demands on their time and on their funds. By taking advantage of a couple of federal income tax credits available to parents, you can help offset the costs of child rearing to a small degree.

Child Care Credits:
For taxpayers who must pay for child or dependent care while they work, there is a tax credit available to help offset some of these expenses. To qualify, the costs must be incurred for the purpose of allowing you (and your spouse if you are married) to be gainfully employed. You must maintain a household for (a) a dependent under age 13 for whom you can claim a dependency exemption, (b) your spouse who is physically or mentally unable to care for themselves, (c) any other dependent who is physically or mentally unable to care for themselves, (d) dependent children of divorced parents if you have custody even though the right to a dependency exemption for the child has been released to the other parent.

There is a limit on the amount of employment related expenses that can be used to calculate the credit. The credit percentage can be applied to a maximum expenditure of $3,000 for one qualifying child or dependent or $6,000 if two or more dependents qualify. The percentage of the expense that can be taken as a credit is based on your adjusted gross income (AGI). If your AGI is $15,000 or less you can take 35% of the dependent care expenditures (up to the maximum noted above) as a credit. If your income is greater than $15,000, the percentage reduces to a minimum percentage of 20% if you income is greater than $43,000.

Another limitation is that you, or if you are married, you and your spouse must have earned income greater than the qualifying expenses. So if you work part-time and earn $2,500, your qualifying expenses cannot exceed that amount. There is an exception if your spouse is physically or mentally incapable of caring for himself or is a full-time student for at least five months of the year.

This credit is filed on your tax return on Form 2441 (Child and Dependent Care Expenses) or on Schedule 2 (Child and Dependent Care Expenses for Form 1040A Filers).


Credits for Higher Education Tuition:
Paying for college for your children can be a very expensive undertaking. There are some credits that can also help defray in a small way some of these costs. These two credits are called the Hope scholarship credit and the lifetime learning credit.

The Hope scholarship credit is available for the first two years of each student’s post-secondary education. The credit has a limit of $1,500 per year. It allows you a 100% credit for the first $1,000 of qualified tuition expense that you pay and a 50% credit for the next $1,000 of qualified tuition expense that you pay. The allowable amount the credit is reduced as your income increases. If you are a single taxpayer, the phase out of the credit begins when your Adjusted Gross Income reaches approximately $42,000 for 2004 and the credits are completely phased out once your income reaches $52,000 for 2004. If you file a joint return, the phase out begins at $85,000 and the credit is completely phased out by the time your joint adjusted gross income reaches $105,000 for 2004.

The lifetime learning credit allows you to take a credit of 20% of qualified tuition expenses you pay for any year that you do not claim the Hope Credit. The maximum allowable credit is $2,000 per taxpayer and does not vary based on the number of students in the your family. The lifetime learning credit also phases out as your income increases. The phase out limits are the same as those for the Hope scholarship.

The credits cannot be claimed by more than one taxpayer in the same year. If your income level would prohibit you from taking advantage of the credit, you can waive your dependency claim and allow your child to take the credit, assuming that they have enough tax liability to claim the credit.

Taking advantage of the credits offered by the Federal Income Tax laws won’t help you with your two year olds’ tantrums, get your eight year old to soccer practice on time, or convince your sixteen year old that curfews still apply to people with a driver’s license. But keeping as much of your money in your bank account instead of the IRS’ will help the financial pain a bit.

For more information, visit the IRS Web site.